These are some funny statistics. First, the assets and the
liabilities don't balance. Second, the "balance sheet" includes
Treasury monetary obligations, including gold and silver
certificates, silver coins, and National Bank notes. On the asset
side, the balance sheet consolidates the gold bullion associated
with those Treasury obligations. An odd way of doing things. Nowhere
does it show exactly how many Federal Reserve Notes were in
existence.

A reminder again: there was some funny business going on during WWI
and afterwards. The Fed (as you can see) engaged in aggressive bank
lending ("bills discounted," i.e., collateralized lending), as part
of a program with the Treasury to keep interest rates low.

This was remedied in the 1920-1921 period. Normalcy didn't really
return until 1922. Let's forget about that 1917-1922 period for now.

As we can see, gold assets generally rose in the early 1920s. The
Fed maintained a consistent amount of "Fed credit," i.e., either
lending or purchases/holdings of debt assets, either "bills bought"
(commercial paper) or U.S. Treasury securities (government bonds).
The mix changed, but the total amount was fairly stable around
$1,250 million. Total Fed credit dips a bit in 1924, and surges a
bit in 1928.

This was consistent with the way the Bank of England and other
commercial banks (such as those thousands of banks that were part of
the National Bank system) operated. They were involved in the market
every day, making loans or buying and selling debt assets. The Fed
was not really intended to do this, but, considering the precedent
and also the role it was pushed into during WWI, it is not too
surprising that it happened.

Previously, I called this a "hybrid system," which included both
purchases and sales of gold bullion at that parity price, and also
purchases and sales of non-bullion (loans and debt) assets, to
adjust the monetary base.

This hybrid system was the most common framework for entities that
managed a currency directly, rather than pegging it to some other
gold-linked currency (i.e. a currency board).

Here is a chart of the Fed's liabilities,
including also "Treasury Currency" as mentioned before. The
total base money, including Treasury currency, is the top line
in pink. Federal Reserve Notes are approximately the difference
between "Money in circulation" and "Treasury Currency." Bank
reserves are barely visible, hidden by total deposits. This is
because bank reserves made up about 98% of total deposits, the
remainder being deposits of the Federal government, and a bit of
deposits from other entities (likely foreign central banks).

Liabilities are well in excess of assets. Like I said, the
balance sheet doesn't balance. This is due, I think, to the
consolidation of "Treasury Currency" on the balance sheet.
Bullion assets related to "Treasury Currency" (including
National Bank Notes) are listed in assets, but non-bullion
assets (bonds) held by currency-issuing National Banks, and the
implied credit of the Treasury, are not listed on the asset
side. Thus, system-wide, there were more credit assets used as
currency reserves than are listed here.

We see a bit of seasonality here. This is the seasonality of
base money demand, with the spike around harvest time that
sometimes caused liquidity shortage crises in the past, notably
in 1907. (The seasonality apparent in this chart is not very
great, especially compared to bank reserves. Reserve
requirements and other factors seem to have played a major
factor in the incidence of liquidity shortage crises,
including in 1907.)

This seasonality is accommodated largely through the issuance of
Federal Reserve Notes, as Treasury Currency doesn't change much.
On the asset side, there's a corresponding seasonality to Bills
Discounted and Bills Bought.

There's a bit of a lift in total base money in 1922-1925, which
corresponds to the lift in gold assets during the same period.
Apparently, people were bringing gold to the various currency
issuers (Treasury, National Banks, and Federal Reserve) and
getting banknotes in return.

The story here is, for the most part, one of placidity. As
mentioned, there were two minor wiggles, in 1924 and 1928. In
1924, Fed Credit dips down a little bit, and gold surges up a
little bit. Apparently, there was a reduction in credit assets
for some reason, which, by itself, would have resulted in a
reduction in the monetary base. This was apparently countered by
the automatic mechanism of gold redeemability/monetization (in
this case monetization), which corrected the reduction of the
monetary base with a corresponding expansion, such that total
base money is largely unchanged (or rather, continues the smooth
curve characteristic of the time period). This makes sense: base
money demand would not be expected to change just because the
Fed is moving assets around. The system automatically corrected
for this. It seems that some observers (Friedman) called this
"sterilization," because gold holdings go up while base money
("high powered money") is largely unchanged. However, I would
say that it appears that the mechanism of gold
redeemability/monetization was fully functional, and was
responding as expected to the changes in the Fed's holdings of
credit assets.

The reason that Bills Discounted (i.e., bank lending) falls is
likely that market overnight rates fell well below the Fed's
discount rate, as you can see on our previous chart of interest
rates. At this point, borrowers would not go to the Fed, and
existing loans would mature and not be renewed. Thus, lending
would contract naturally. The question then is: why did
overnight interest rates take a dip in 1924? This could be
because of additional base money creation from some other means,
such as purchases of Treasury securities. The additional base
money would end up as bank reserves, banks would have more than
they need, and would thus want to lend out the excess to make a
profit. Something of the sort did happen in 1924, although the
decline in Bills Discounted is greater than the increase in
Treasury Securities, so there is a little more to it than that.

Toward the end of 1924, it looks like these Treasury bond buys
were a little too aggressive, and people began to take their
banknotes to the banks to be redeemed in gold. The Fed reacted
by selling Treasury bonds, and the gold outflow stopped. These
were all rather subtle movements I would say, basically
irrelevant in the larger picture, particularly as total base
money didn't really change much if at all.

The next event of some note is in 1928. It seems to begin with a
little rise in Treasury Securities and consequently total "Fed
Credit", which leads to a reduction in gold bullion apparently
due to redemption. Treasury securities are sold, apparently in
response to the gold outflow, but one consequence is a rise in
overnight rates in 1928. The result is that overnight rates are
well above the Fed's discount rate, leading to an increase in
Bills Discounted and overall Fed Credit. The problem is remedied
by a number of increases in the Fed's discount rate. Bills
Discounted levels off, and the gold outflows stop. The result is
that overall Base Money is very flat during this time.

The increase in overnight lending rates in 1928-1929 was related
to the stock market boom. At the time, it was quite common to
use very aggressive margin for stock purchases, even up to ten
times leverage. This margin was financed by overnight borrowing,
as noted before, mostly by brokers in the form of Stock Exchange
Loans. The increasing rates denotes a very high demand for funds
from brokers to fund stock margin lending. The high rate also
probably reflects the increasing perception of risk from the
lenders, mostly banks. Long term rates were essentially
unchanged during this period.

This discussion might seem rather arcane, so let's summarize
some conclusions. What we see here is a hybrid system that
includes gold bullion monetization/redemption, and also regular
transactions in forms of credit including direct lending,
transactions in commercial bills, and transactions in Treasury
securities. The Fed maintained a constant presence in the
lending market, carrying a balance of Bills Discounted (i.e.,
lending), which was in turn related to the Fed's discount rate
and its relationship to short-term market rates. Also, the Fed
bought and sold Treasury securities (and Bills Purchased) based
on its own discretion, adjusting to the conditions of the time,
which also had an effect on overnight rates and thus Bills
Discounted. All of this added up to the Fed Credit portion of
the balance sheet -- and the corresponding amount of base money
created by these means. The Fed Credit portion goes up and down,
although for the most part these moves are minor in the overall
scheme.

Total Base Money is rather smooth during the period. This
reflects the demand for base money, within the context of a gold
standard system, which automatically adjusts the supply to meet
the demand such that a stable gold parity value is achieved.
This was apparently accomplished by the gold bullion
monetization/redemption function, such that any surplus or
deficiency of base money from the Fed Credit functions was
automatically corrected, producing the smooth curve of Base
Money as noted.

This might seem rather confusing, but it was the way things were
generally done in those days -- not only by the Fed, but also by
other major central banks like the Bank of England and also the
thousands of note-issuing commercial banks that were part of the
National Bank System. From this you can get an idea of why the
Bank of England's discount rate became the primary locus of
attention regarding the BoE's gold standard operational policy.
If the Bank of England's discount rate was well above the market
overnight rate, the BoE's lending would contract, and thus pound
base money would also contract (a result that would likely lead
to increased gold inflows/monetization to compensate). This
would support the currency. If the Bank of England's discount
rate was such that BoE borrowing became more attractive than
other alternatives, the BoE's lending would expand and base
money would expand. In the BoE's case, this too was accompanied
by the gold bullion monetization/redemption function, and also
transactions in British government bonds.